Bond Markets Hit by Oil Shock

Matthew Diczok, head of fixed income strategy, Merrill and Bank of America Private Bank said the market doesn't expect their to be a sustained increase in energy.

he world’s bond markets were whipsawed by unusual volatility as investors rushed to bet on higher interest rates after key central banks signaled fresh concern the surge in oil prices will deliver an inflation shock.

Three weeks into the war in Iran, the fallout unleashed a major repricing of short-term bonds during much of Thursday’s trading day by dashing once widespread expectations that central banks would cut rates this year to spur growth.

The selloff was led by the UK, where the surge in yields held echoes of 2022, when former Prime Minister Liz Truss’ fiscal plans sent the market into a tailspin. The two-year rate jumped as much as 40 basis points to 4.49% after the Bank of England on Thursday said it “stands ready” to act to prevent inflation from accelerating. - Turmoil in the Middle East sparked fresh losses across stocks and bond markets. The dollar strengthened. The UK 10-year yield hit the highest level since 2008.

US stocks are heading for a fourth week of declines as investors, many of whom expected a short war, grapple with a conflict that has upended energy supply chains and reignited fears over inflation. S&P 500 futures fell 0.3%. Two-year Treasury yields added five basis points to 3.84%. Brent traded around $107 a barrel.

Iran pressed ahead with attacks on Gulf states even after Israel signaled it would refrain from hitting the Islamic Republic’s energy operations. Meanwhile, Axios reported that the US is considering taking over Iran’s Kharg Island, a key oil-export site, to put pressure on Tehran to reopen the Strait of Hormuz.

US equity traders are also bracing for an unusually large tally of options expiring on Friday. Roughly $5.7 trillion in notional options tied to individual stocks, indexes and exchange-traded funds are set to expire, the largest March expiry in Citigroup Inc. data going back to 1996.

“We’re in a vulnerable environment at the moment with possible interest-rate hikes and Brent above $100,” said Nicolas Forest, chief investment officer at Candriam in Brussels. “If the Stoxx 600 and the S&P 500 are not able to hold technical levels today, this might signal upcoming stress.” Europe’s Stoxx 600 trimmed earlier gains of 1%. The yield on 10-year UK gilts rose as much as 10 basis points to 4.94%, the highest since the financial crisis. Shorter-dated yields surged even more. Money markets are fully pricing in three interest-rate hikes by the Bank of England and the European Central Bank for 2026.

Gold steadied above $4,650 an ounce, but remained on track for its worst weekly drop since the onset of the pandemic. Bullion is down nearly 7% this week, the most since March 2020, as traders dialed down expectations for central bank rate cuts.

Long-only investors sold $9.6 billion across Goldman Sachs Group Inc.’s trading floor on Thursday, the largest day of net selling in the investment bank’s data set going back to 2022. The supply was broad and across all sectors, team members Ariana Contessa and Mike Washington wrote in a note.

“The market was wrong at the start of the conflict, thinking it would end swiftly,” said David Kruk, head of trading at La Financiere de l’Echiquier in Paris. “Investor sentiment has clearly shifted into a more bearish positioning.”

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